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Real Estate Incentives Identified

New Markets Tax Credits (NMTC): What is it?

What is New Markets Tax Credits (NMTC)?

The New Markets Tax Credit (NMTC) program is designed to encourage the introduction of capital by a private investor, typically a financial institution, to a commercial project, see a list of example projects below, which is located in the right location. This means, a commercial project, may be able to attract capital just because it is located in the right location.

The NMTC program allows a financial institution to invest in businesses located
in a qualified location. For making this investment, the financial institution receives
a 39% tax credit (39 cents for each dollar invested) of its total investment, which
the financial institution receives over a 7-year period. Because the financial institution
receives the 39% tax credit (year 1, 5%; year 2, 5%; year 3, 5%; year 4, 6%; year
5, 6%; year 6, 6%; year 7, 6% = 39%) over 7-years it is typically committed to the
project for the 7-years. The tax credits are used by the investor (financial institution)
to offset its tax liability. Even thought the tax credits are received by the financial
institution over the 7-year period, the financial institution must make its entire
investment, in the first year, which money is made available to the project.

The key question for anyone interested in NMTC financing is how much equity will
remain in the project once the financial institution leaves the deal in year 7.
The answer to that tees off of how much the investor paid for the tax credit. The
higher the price paid per tax credit, the more capital is left in the project. Many
variables drive that yield calculation, therefore, the amount fluctuates. For example, if the an investor purchases the 39% tax credit for 60
cents, then project will see a 23% net benefit at the end of year 7, which means
that a $10 million dollar project should be left with $2.3 million at the end of
year 7, and $7.7 million will need to be refinanced.

How does NMTC work?

The equity investment made by the financial institution is passed through a third-party
entity called a community development entity (CDE). The CDE holds the tax credits
sought by the financial institutions. There are numerous CDEs that are affiliated
with the financial institutions. The CDE receives the tax credits from the
CDFI Fund, which is administered by the US Department of the Treasury.The
capital investment that the CDE received from the financial institution passes through
it and the money is made available to the project. Because of the tax credits, which
the financial institution receives for making the capital investment, the money
received from the financial institution is passed to the project at as free capital
(equity), below market interest rates, with interest-only payments for 7-years,
and/or part of the debt is forgiven at the end of the 7-year period. The amount
of the free capital (equity) investment, the below-market interest rate, and/or
the amount of the debt forgiven are based on a desired yield by the financial institution.
At end of year-7, there is an exit strategy for the financial institution. Typically,
the financial institution has no interest in the project after it exists.

Projects must be located in qualified locations to be eligible for NMTC financing,
or benefit certain targeted populations. Projects have a better chance of being
considered if they are in economically distressed areas and will have substantial
community impact.

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